Opinions such as those of Mr Greenspan, who was warning about the possibility of a sharp correction in the Chinese markets, have been quickly forgotten and the move continues. In the end, it seems that the ‘strong hands’ are trying to prepare the ‘weak hands’ to buy their assets when they finally consider it time to cash in their profits and this means one still has to find a buyer who is willing to pay the present market levels. This would be difficult without drawing a positive picture of the future.

Oil prices rose sharply again, mainly because of stronger seasonal demand for distillates and due to political influences. The Chinese central bank was tightening the money supply again by increasing refinancing conditions. Business outlook and consumer influence in Germany rose strongly and, depending on the announced re-engineering of the French economy taking place successfully, the two largest European economies could create a strong base for the successful future of the euro zone.

The financial markets are already giving a lot of credit to the developments reflected in the strong value of the €, which now awaits confirmation in the real world. In the meantime, the € lost a little of its shine or, more accurately, the $ regained some. Financial data from the USA, and particularly from those in the housing market, has made investors believe that the outlook for the US economy is better than expected and has dampened expectations for a US interest rate cut in 2007. By consequence, the $ took a break in its approach to the 1.40 level and fell back from the record high to levels within the 1.34-1.35 range. The market is presently undecided about the next trend and has decided to enter a period of ‘range trading’ for the moment.

Market intelligence

The general correction mood which we have been seeing since the beginning of April also persisted in the last two weeks. However, the pattern is changing a little as market pressure is not evenly spread across all grades. The standard items for the shoe industry continue to find strong resistance and the medium to higher end raw materials for automotive tanning are not finding enough support from buyers to support their price levels. On the other hand, standard upholstery hides, and better quality dairy cows in particular, are performing much better than one would have expected.

Prices for steers and heifers continued to slide and dairy cows and low grades were better able to defend their levels. Trading activity could be described as moderate, which is nothing unusual at this time of the year, but doesn’t suit origins with a high seasonal slaughter.

As far as market news is concerned, the key notes came from Asia, and largely from China. Gossip and rumours swirled around one of the largest tanners, which is said to open L/Cs pretty selectively now. More to the point, it is not opening for the more expensive origins and is leaving suppliers from the USA and Europe with hides ready for shipment according to contract, while Australian and other American contracts are honoured. Even though no official confirmation is available, there are enough reliable sources reporting this to suggest that the story appears to bear some truth, either in part or as a whole.

    Other pundits are reporting their observation that the tightening of money supply and the rise of interest rates are also leaving tracks now. An increasing number of reports state that documents are only accepted with delays and transfers are exceeding the usual timeframes or are effected outside the usual periods accepted between international banks. It is left to the individual to decide whether this is an agreement between importer and bank to save interest or whether it is an early sign of liquidity shortages.

Taiwanese producers in China see Taiwan as alternative

This leads us on to a discussion about the consequences of expiring Chinese customs handbooks in 2008. A number of people close to the scene believe that a lot of joint venture companies—particularly from Taiwan—are thinking about withdrawing their production from China. If this really is the strategy, it will affect imports of raw material to China after October this year and the flow of product must be redirected, either back into Taiwan or into new fashionable destinations such as Vietnam or Indonesia. Thailand, which has always remained a production location for some Taiwanese groups, has been fancied for a while and has potential for growth. However, this will not change very much as it would not ultimately change the demand for shoes or leather and companies are normally smart enough to handle such situations, especially when they have had enough time to prepare for whatever they consider will influence their business.

Returning to the market as such, we are now seeing seasonal and regional influences that might impress the ‘day-traders’ in the market, but are less likely to impress those monitoring market and price developments from a wider perspective. Fundamentally, not much has happened so far. If we look at price movements over the last eight weeks and at the corrections, one quickly determines that any more significant changes than the minor market fluctuations have only occurred in markets that had previously been overshooting and were fairly overvalued. In some cases, one could even question whether the prices quoted during the peak period were a real trading level or whether they were simply a reflection of sellers’ enthusiasm and sales strategy.

Little likelihood of major long-term downward corrections

However, if we just take the US steer market, the French and south German hides or a great part of the calf and kip market as examples, one has to be sceptical about the price levels reached anyway. Major price corrections in the market basically hit these hides and they have been generalised to a market trend that is—at least so far—not justified.

Once again, this leads us to the key question of real interest: is the hide market now entering a new cycle after almost 18 months of a bull market and could it turn into a longer bear market trend now as a result of the overvalued hides reaching the other markets? Well, in the first instance, we do not think that we are at this stage at the moment. In our view, we are still in a general correction and price adjustment phase, and there are few arguments for a longer, extended trend for substantially lower prices. This is mainly because the global economy is still growing at pretty high levels, but also because consumer business remains fairly strong and because the supply side is not showing any signs of substantial increase.

Growing trends for non-leather footwear

If there is anything at all that is seriously worrying, it is a trend toward using more and more leather substitutes in shoes, and this is gradually being accepted, in some market segments at least. When visiting football pitches today, one can easily see that the vast majority of youngsters are playing in brightly coloured football boots that are, in the vast majority, 100% plastic. The same applies for indoor football, which explains why splits are doing so badly at present. One could look at the success of Crocs shoes, which are 100% rubber, as a fashion niche suitable only for ‘good weather’ regions, but this could also increase the acceptance of ‘non-leather’ shoes in general. It is pretty unlikely that this will hit the leather shoe market hard in the short term, but it needs to be watched carefully and one would be well advised to monitor the next collections of mass market shoes to determine whether anything has changed as far as the materials used are concerned.

In an attempt to reflect all the options, we should also specify what we would consider to be the fundamental scenario for a longer, and more pronounced, downswing for raw material prices. It would require an overloaded supply pipeline, and one that is not undersupplied as it was until the first quarter of this year. When the last cycle started sometime in 2005 there was little confidence in leather demand and the business future. Tanners were deeply impressed by the low demand, restructuring and the process of globalisation, the effects of which many businesses were unable to predict. The consequence of this was that hardly anyone trusted improvements in conditions and inventory planning remained hand-to-mouth and lagged behind the order reality for a long time. Beside the physical effects in the pipeline—constant low or insufficient inventory in the production pipeline—it also created insufficient margins, as a larger part of the tanning industry had to replenish inventories at ever-rising raw material prices and were not in a position to operate from sufficient and adequately priced raw material positions to secure profit margins. Later in the cycle, towards the end of 2006, confidence about the situation was growing, as was a fear of further rising raw material prices in combination with very promising budgets presented by manufacturers and retailers. The industry started to build larger stocks in correlation with their more optimistic outlook and this shifted inventory positions further forward through the supply chain.

Current optimism shown by buyers and sellers

This worked well until a certain seasonal slowdown in the leather business occurred. Everybody was happy as long as prices and demand seemed to outpace supply. Raw material sellers were happy as their returns seemed to have only one direction and buyers thought that they had finally made the right decision in keeping higher stocks or supplies under contract at reasonable average prices. We think that this is the present situation of the market and this is where we will start from.

If we were to have a severely overloaded stock position this would be the foundation of a bear market. The psychological and commercial consequence is normally a slowdown in purchasing activity in the hope of reducing stocks quickly and a delay in replenishment in order to force prices lower and average inventory values down. If leather business does not meet expectations, this will trigger a downward price spiral, and this is not normally a short-term price reaction.

We do not think that the probability of a long-term and significant price reaction is high. As indicated above, global leather demand remains intact and all we see today is a correction in the price structures for leather and raw materials. It seems pretty unlikely to us that this will result in a longer trend for lower prices and it would require more time to produce a serious evaluation. Certain trends should be monitored, but for the next season it still seems too early for a fundamental change. One thing is true, however. The firm market and higher prices for raw materials have forced manufacturers to discuss the downgrading of raw materials and the use of alternative products in order to meet price targets. This does not mean non-leather products, but could include alternatives such as skins instead of hides.

Bleak outlook for splits and skins continues

The disastrous situation in the splits market remains a mystery. It is hard to find anyone these days that is not reporting on the pretty poor status of the splits market. The Chinese are again playing a key role here. Our sources report low demand, large stocks, big claims and slow sales. This is really what a weak market is made of and we find it difficult to understand why splits are performing so poorly when prices and calculations have become such an issue. The main explanation is that, comparatively, splits are not finding a place in the market at the right price, for shoes at least. They are not cheap enough to compete with plastic and not good enough to perform as a ‘real leather’, full grain product. There must be some truth in this, justified or not, as it is difficult to find any other convincing explanation as to why splits prices and market balances have reached the situation they are in today.

The skins market also remains in a shakeout. While skins carrying a good quantity of valuable wool are still fancied by Chinese buyers and the drought in Australia is also worrying the supply side, the standard nappa and double face skins are still difficult to move and are not proving exciting anymore compared with the interest they provoked some time ago. It is mainly the double face market, which is just approaching the new season, that still needs to sort itself out. There are a number of important questions at the moment, such as where will prices for the top quality skins settle? What is their quality level this season? What is the future programme of Turkish tanners, who still play a key role in the market? Will the drought in Australia have a longer-term effect on skins prices? And will more skins be used for shoe production in the coming seasons? These questions will need to be answered over the summer in order to clarify the position for skins and their price trends.

We still do not believe that the high level of uncertainty which plagues the trade will disappear in the coming weeks. One senses that nobody wants to make mistakes and, after a long period of stability and clear market conditions, the pipeline is struggling to handle the situation. Tanners are afraid to buy too early in their attempts to buy as cheaply as possible, and sellers are debating whether it is better to sell or to hold if the price is not right. As we have already explained, we do not think that there is anything special to report yet. Certain hide prices simply had to be brought back into line and it always takes time for everything to be shaken back into a certain equation and for prices to settle. The US market remains the key, with prices in Brazil next. The fundamentals remain pretty much intact, but in a market like today’s, which is pretty sensible, individuals’ decisions can sometimes trigger the next move, and it seems that not everyone is in the same position or has the same market opinion. So, we continue to believe that the weak/steady description may still be the most adequate forecast for the moment.

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